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Among the first lessons many small-business owners learn is the value of positive returns. Lessons learned apply anytime you invest money, whether it’s in the open market, in equipment or in hiring employees. However, to make truly wise investment decisions, it’s just as important to understand and know how to balance the relationship internal return rates and margin expectations share with your bottom-line profit.

Return Rates and Margin

Both internal return rates and margins link directly to profitability. The internal rate of return reflects a positive or negative relationship between an investment and profit. For instance, the interest rate you pay or receive, costs associated with acquiring and maintaining a capital asset over its useful lifetime and employee productivity all have internal rates of return that affect profitability. In contrast, both gross and net profit margins show a positive or negative relationship between profit and gross or net sales.

About Investment Returns

You invest in your business not to simply break even but to support profitability. An internal rate of return calculation helps you determine whether the return you’re getting is greater than its associated costs or an established minimum acceptable rate of return. If the ratio calculation projects a positive return -- a return that exceeds costs or the minimum established rate -- the investment supports profitability goals. However, if the ratio calculation projects a flat or negative return, the investment undermines profitability goals.

Project the Internal Rate of Return

Calculate the internal rate of return as the first step in balancing returns and margin. While the formula for calculating the internal rate of return is complex, and most often best left to your accountant, it’s less difficult to understand. The internal rate of return is the interest rate at which the future monetary value of returns from an investment equal the money invested. It’s the minimum return percentage necessary to break even on an investment. The result of the calculation tells you how far you are from a breakeven point on either side of the equation.

Balancing Returns and Margins

Predetermined margins are the determining factor in balancing returns and margins. There is no set balancing formula, but it instead requires decisions based on information such as long-term goals and annual planning data, specific to your business. Decide on the point at which you consider an internal rate of return and margin to balance. For example, you might decide the returns from a capital investment balance when returns support at least 10 percent of a gross profit margin of 40 percent. Compare internal rate of return results against the margin benchmark. If it’s not balanced, either go back and look for ways to increase the internal rate of return or decide against making the investment.

About the Author

Based in Green Bay, Wisc., Jackie Lohrey has been writing professionally since 2009. In addition to writing web content and training manuals for small business clients and nonprofit organizations, including ERA Realtors and the Bay Area Humane Society, Lohrey also works as a finance data analyst for a global business outsourcing company.